Venture Capital Disrupts Itself: Breaking the Concentration Curse

Research Note
November 2015
Private Investment Series
Venture Capital Disrupts Itself:
Breaking the Concentration Curse
The Old Wives Tale … Conventional investor wisdom holds that a concentrated
number of certain venture ﬁrms invest in a concentrated number of companies
that then account for a majority of venture capital value creation in any given year.
Therefore, LPs seeking compelling venture capital returns should only commit to
a handful of franchise managers. And those are precisely the managers that do not
offer access. Thus, LPs are “cursed” and will never experience the differentiated
return pattern offered by venture capital exposure.
… Is Flawed. As the venture capital industry and technology markets have
evolved and matured, however, more managers are creating signiﬁcant investment
value for LPs, with value increasingly created through companies located outside
the United States and across a range of subsectors. Speciﬁcally, our analysis of the
top 100 venture investments as measured by value creation (i.e., total gains) per
year from 1995 through 2012, an 18-year period, demonstrated:
• an average of 83 companies each year account for value creation in the top 100
investments in the asset class for each year;
• in the post-1999 (i.e., post-bubble) period, the majority of the value creation in
the top 100 each year has, on average, been generated by deals outside the top
10 deals;
• an average of 61 ﬁrms account for value creation in the top 100 investments in
venture capital per year; and
• the composition of the ﬁrms participating in this level of value creation has
changed, with new and emerging ﬁrms consistently accounting for 40%–70%
of the value creation in the top 100 over the past 10 years.
In short, the widely held belief that 90% of venture industry performance is
generated by just the top 10 ﬁrms (which our analysis shows was somewhat
relevant pre-2000) is a catchy but unsupported claim that may lead investors
to miss attractive opportunities with managers that can provide exposure to
substantial value creation.

Research Note
November 2015
Broad-Based Value Creation
For the 18 years covered by this analysis, the top
100 investments accounted for a percentage of
total value creation that ranged from a minimum
of 72% in 2012 to a maximum of over 100%
across several years, making this a robust data
set to analyze (our methodology is described
in the sidebar). The top 100 deals’ total gains
outstripped the total gains of the asset class in
each of the years that marked the dotcom crash
(1999 to 2003) and in 2005 and 2006 (Figure 1).
This fact was particularly salient in 2000, when
the asset class as a whole generated a net loss,
while the top 100 showed a gain, as well as
in 2001, when the total gains of the top 100
accounted for 217% of the asset class’s gains.
Yet, make no mistake: there is substantial,
broad-based value creation in venture capital.
Post-1999, investments ranked 11 through 100
accounted for an average of 60% of the total
gains generated by the top 100 investments per
investment year (Figure 2), besting the top 10.
The exceptions to this trend were 2005 and
2010, which were driven by investments in two
outstanding companies, and 2011, which is still
developing from an investment maturity standpoint. This is in contrast to the pre-2000 period,
in which the top 10 investments accounted for
an average of 57% of the total gains, ranging
from 44% to 68%. Indeed, after 1999, the
pooled gross MOIC generated by the cohorts
appears to have stepped down from the lofty
highs of the comparable tech bubble cohorts.
Minding the Multiples. While much is being
said about unicorns, deﬁned as venture-backed
companies that achieve a $1 billion valuation,
investors should stay in vigilant pursuit
of those managers making venture
investments that deliver substantial total
gains on the valuations they have paid.
Data Set and Methods
For the purposes of this analysis, value creation is represented by total gains, deﬁned as the total value, realized or
unrealized, of a given investment less that investment’s total cost. While there are other approaches, including total value
or gross multiple on invested capital (MOIC), investments ranked by total value include large investments with little value
appreciation, while investments ranked by MOIC include investments with high multiples but low absolute value creation.
Total gains, in our view, measure a manager’s ability to generate proﬁt on an investment, which is a better metric for
comparing the performance of different-sized investments. We then narrowed our focus to the top 100 investments per
initial investment year (with cash ﬂow and valuation data aggregated by initial investment year), as ranked by total gains.
Beginning with 1995, the ﬁrst year in which the aggregate total gains in venture capital exceeded $10 billion, our analysis
continues through to 2012, which, while still a relatively recent investment year, captures the value created by some
noteworthy high-growth investments.
In total, these 1,800 investments, representing 1,211 companies, were made by 682 funds, representing 265 global venture
capital managers. As the total gain analysis focused on discrete investments done by venture managers, we examined the
extent to which any top 100 investments in a given year were different managers investing in the same company; since
2000, an average of 83 unique companies have been represented in the top 100 investments in each year. The difference
between 100 and 83 is due to multiple funds investing in the same company in a given year.
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Research Note
November 2015
Figure 3 demonstrates that substantial value
creation is very much alive and well, depicting
gross MOIC dispersion of the top 100 total
gains from 1x–3x all the way through to
10x–25x, and our favorite, 25x+. Analysis incorporating these ranges is likely not on offer in any
other investment strategy, and underscores the
opportunity for investors. Deals that generated
a gross MOIC of 5.0 or greater accounted for
an average of 85% of total gains in the top 100
investments per investment year, and in most
years, at least 60% came from investments that
generated a gross MOIC of at least 10.0. The
pooled gross MOIC for investments outside the
top 10 was greater than 4.6 in all mature years
(i.e., excluding 2011 and 2012) included in the
sample set, and the average pooled gross MOIC
of deals outside the top 10 across the entire data
set was 8.5. As with Figure 2, one can see the
two eras of venture capital quite clearly, with an
average pooled gross MOIC pre-2000 of 32.8
versus the average of 7.8 after 2000.
The Unusual Suspects: Not Just Silicon
Valley-based, Consumer Internet
Investments Driving Returns. Companies
represented in the top 100 investments show
increasing diversity. Although many investors
have abandoned investing in health care venture
capital, health care investments accounted for
10% to 30% of the total gains produced by
the top 100 investments in most years. Seedand early-stage investments have accounted
for the majority of investment gains in every
year since 1995 (Figure 4), suggesting that
despite the deep pockets of late-stage investors, early-stage investments hold their own on
an apples-to-apples basis (total gains). Within
the United States, the share of the top 100
investments originating from outside of the
Figure 3. Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Gross MOIC Range
As of December 31, 2014
1x–3x
3x–5x
5x–10x
10x–25x
25x+
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Initial Investment Year
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Research Note
November 2015
Figure 4. Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Initial Deal Stage
As of December 31, 2014
Expansion/Late Stage
100%
Seed & Early Stage
90%
80%
70%
60%
50%
5.9x
30.3x
7.6x
10.6x
6.1x
4.0x
43.1x 21.7x
23.0x 56.5x
5.6x
7.8x
5.5x
2001
2002 2003 2004 2005
Initial Investment Year
7.0x
9.6x
11.5x
7.5x
8.0x
2007
2008
9.5x
12.7x 10.9x
7.1x
7.0x
5.5x
3.0x
2010
2011
2012
40%
30%
20%
9.3x
1996
10.4x
55.4x
1995
0%
6.9x
70.8x
10%
1997
6.0x
1998
1999
2000
5.8x
traditional venture capital hotbeds of California,
Massachusetts, and New York has consistently
been at least 20% of the total gains created, and,
in 2004, roughly 50% of gains from US investments came from investments based outside
these major hubs.
International investments have accounted for
a larger share of the top 100 gains: from 2000
through 2012, they represented an average of
20% of the total gains in the top 100, compared
to an average of just 5% from 1995 to 1999, and
they reached as high as 50% of gains in 2010
(Figure 5). China, in particular, has emerged as a
venture capital hotbed. Europe’s venture capital
activity has continued to accelerate in recent
years, propelled by successes in technology
companies across a variety of subsectors. The
tailwinds of lowered costs of company creation
and increased access to cloud computing
infrastructure (discussed in more detail later),
7.6x
5.8x
8.7x
2006
7.8x
2009
coupled with changing cultural mindsets around
entrepreneurship and risk-taking, suggest that
international deals will account for an increasingly large share of the top 100 deals going
forward.
Make Room in the Winner’s Circle. The
composition of venture managers participating
in the top 100 investments is not static. To
be sure, certain franchise Silicon Valley ﬁrms
continue to invest in an impressive number of
the top 100 investments, but in every year since
2000, at least 57 ﬁrms have accounted for at
least one of the top 100 investments, with the
proﬁts from those investments shared more
broadly across the industry than conventional wisdom would assert. Moreover, in the
post-1999 period, an average of 65 ﬁrms per
year made investments in the top 100, a 33%
increase from the average number of ﬁrms that
made top 100 investments in the bubble period
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Research Note
November 2015
Figure 5. Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Deal Geography
As of December 31, 2014
Ex US
100%
US
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1995
1996
1997
1998
1999
2000
2001
2002 2003 2004 2005
Initial Investment Year
(including those ﬁrms that succeeded in the
bubble and subsequently underperformed and
wound down). Further, for the last 10 years,
40%–70% of total gains were claimed by
new and emerging managers, a clear signal
to investors to maintain more constant
exposure to this cohort (Figure 6). This
makes sense: emerging managers have shown
an increased willingness to capture the greater
diversity in investments occurring in the top 100.
For example, in the post-1999 period, 25% of
the total gains driven by emerging managers in
the top 100 have come from ex US investments,
versus just 11% for established managers (Figure
7). Emerging managers are also highly likely
(though not necessarily more likely than established ﬁrms in the top 100) to make their initial
investments at the seed- and early-stage.
2006
2007
2008
2009
2010
2011
2012
There are more winners, and even the elite top
10 ﬁrms per year have turnover. Although in the
post-1999 period, the top 10 ﬁrms in a given
year account for (on average) roughly half of the
total gains generated for such year, there is little
concentration in the ﬁrms that represent the top
10 over time. From 2000 through 2012, 70 ﬁrms
registered at least one top 10 deal, ﬁrms with
a top 10 deal accounted for an average of just
1.4% of the total number of top 10 deals across
the period (i.e., 130 deals in aggregate), and no
ﬁrm accounted for more than 7.7% of the top
10 deals across the period. This compares to the
pre-2000 period, in which just 25 ﬁrms had at
least one top 10 deal and ﬁve ﬁrms accounted
for at least 8% of all the top 10 deals in the
period. Therefore, it behooves investors to
have adequate diversiﬁcation in their venture
programs.
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Research Note
November 2015
Smaller Funds Hold Their Weight. Examining
the characteristics of these managers by fund
size reveals that the industry has shifted from
clear dominance by funds of less than $500
million in the pre-2000 era to a more dispersed
distribution of fund size (Figure 8). That said, since
2005, managers with funds of less than $500
million have accounted for at least 50% of the
total gains in the top 100 investments, including
ﬁve years accounting for more than 60% of
the total gains in the top 100. More speciﬁcally,
from 2000 through 2012, funds of less than
$250 million accounted for an average of 20%
of total gains, and funds of $250 million to
$500 million accounted for an average of 36%
of total gains. A small fund does not necessarily
signal an emerging fund—some more established ﬁrms have recognized the logic in raising
smaller, more focused funds and are doing so.
Why Value Creation Is
More Broadly Dispersed
The progression of the composition of investments in the top 100 and the ﬁrms that invest
in them illustrates the need for venture ﬁrms to
remain as dynamic as the markets in which they
invest.
Continued technology innovation, the expansion
of start-ups beyond traditional tech hubs, and
the changing needs of entrepreneurs from their
venture capitalists have enabled the creation
of new, innovative venture ﬁrms, have forced
established ﬁrms to innovate their own models,
and could further de-concentrate value creation
in the industry.
Figure 8. Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Fund Size
As of December 31, 2014
<$250mm
100%
$250mm–$500mm
1999
2001
$500mm–$750mm
≥ $750mm
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1995
1996
1997
1998
2000
2002 2003 2004 2005
Initial Investment Year
2006
2007
2008
2009
2010
2011
2012
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Research Note
November 2015
Technology Trends Impact Scale, Time-toMarket. A number of substantial technological
trends in information technology and health care
have enabled the emergence of new companies
that have developed signiﬁcant scale in a short
period. The pace of innovation continues to
accelerate, and innovative startups are increasingly addressing global markets from the
moment they begin selling products. The pace of
innovation is evident in information technology, as
the cloud computing stack (software-as-a-service,
platform-as-a-service, and infrastructure-asa-service) continues to transform enterprise
software and new pioneers disrupt large
incumbents; in mobile, as the proliferation of
smartphones enables the rapid emergence and
success of companies with business models
that depend on mobile; and in health care, where
the falling costs of gene sequencing are now
enabling widespread use to transform modernday drug research, development, and, ultimately,
therapies and diagnostics.
The Lean Start-Up and Its Effects. The
declining costs of building technology companies have enabled technology entrepreneurship
to expand beyond traditional venture capital
hubs. Easily accessible, scalable, cloud-based
computing capacity has obviated entrepreneurs’
need to invest substantial capital in infrastructure
hardware, which has in turn led to high-quality
companies being created in a wider range of
geographies. In the United States, an increasing
number of top 100 total gain investments have
emerged from outside traditional hubs. Seattle
and Los Angeles, in particular, have enjoyed
success, while the Midwest has a burgeoning
entrepreneurship ecosystem. Aside from Israel,
other regions in Europe and Asia—sometimes
aided by government incentives—continue
to capitalize on their technical talent and are
embracing the risk-taking culture necessary to
create large technology companies. US-based
venture ﬁrms willing to invest in less trafﬁcked US regions and abroad, as well as
venture ﬁrms based internationally, have
captured the value created by a broadening
geographical opportunity set.
Evolving Support for Portfolio Companies.
The evolution in the startups that constitute
the venture capital opportunity set has forced
venture ﬁrms to re-examine their roles as
venture capitalists, with many focused on how
they can improve the ways they add value to
portfolio companies. Venture ﬁrms can no
longer simply compete on capital alone;
entrepreneurs today have options and
venture capital is not the cottage industry
it once was. Given the explosive growth rates
that changes in technology have enabled (as
described in the preceding paragraphs), venture
ﬁrms have increasingly focused on how they can
help their companies scale in an sustainable, efﬁcient manner. One model gaining some traction
is giving portfolio company entrepreneurs a
team of operating professionals to rely on for
the functional areas of their business in which
they want advice. While this harkens back to
the bumper crop of incubators or ﬁrms with
business development professionals in their
ranks during the tech bubble, some thoughtful
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Research Note
November 2015
ﬁrms have considerably evolved this model
and added other components, such as creating
a community among portfolio companies
that entrepreneurs can leverage, which has
engendered respect and loyalty among the tech
entrepreneurial community.
Venture Capital Firms Are Not Your
Father’s Oldsmobile; Rather, Think Tesla.
A prominent trend contributing to the success
of emerging ﬁrms has been the rate at which
entrepreneurs spin out of large, successful
(and formerly venture-backed) technology
companies. Simultaneously, emerging principals
and partners at existing venture capital ﬁrms
have shown an increased appetite for spinning
out and starting their own ﬁrms and building
platforms they see as best suited to address the
market opportunity. Part of these newer ﬁrms’
success relates to their networks with younger
entrepreneurs; however, these venture ﬁrms also
deserve credit for pioneering a new wave of
specialization of venture capital. While 10 years
ago investors may have referred to a specialized ﬁrm as one focused only on technology,
the emerging ﬁrms succeeding today have
reﬁned their focus to certain subsectors (such
as IT infrastructure and ecommerce) or certain
themes (transformational data assets). The
sharper focus on subsectors enables ﬁrms to
carve out niches in an increasingly competitive
market.
Conclusion
The dynamism of technology and health care
markets since the bubble period has broken
venture’s concentration “curse.” High-quality
companies are increasingly created in many
corners of the world on relatively lean models.
The entrepreneurs of these companies are often
younger, increasingly do not come from Silicon
Valley, and do not need to rely on an insular
group of networks to get funded or build their
companies.
Given the proliferation of these technology
trends and entrepreneurs, the majority of gains
in the top 100 venture investments are no
longer concentrated in the top 10 investments
in a given year; moreover, the strong aggregate
performance of the other 90 demonstrates the
value of the broader venture capital industry.
In every era, new ﬁrms have emerged and
succeeded with focused models, relevant experience, and fresh networks that address the
opportunity set before them. Indeed, some of
these ﬁrms have forced established ﬁrms to
innovate their own models to stay competitive.
The next era will contribute its own evolutionary
traits to venture capital. Investors that selectively
add exposure to managers embodying these
traits should be better positioned to beneﬁt
from venture capital’s own version of creative
destruction.
Venture capital’s dynamic nature and its maturation mean investors are able to build successful
venture programs without “franchise funds.”
However, venture capital portfolio construction
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Research Note
November 2015
remains challenging; rigorous due diligence and
selectivity are critical in adding newer managers
and established managers alike to a portfolio.
Only institutions with truly long time horizons
(10 to 15 years) and the ability to absorb an
extended J-curve (negative returns) should
embrace this high return asset class. This is not
appropriate for investors with short-term performance objectives, or those not comfortable with
spending both time and money over many years
to understand the ever-changing opportunity
that is venture capital. ■
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Research Note
November 2015
Theresa Sorrentino Hajer, Managing Director
Nick Wiggins, Associate Investment Director
Frank Cicero, Senior Investment Associate
Venture Capital Value Creation: Top 100 Investments Compared to Total Asset Class
Source: Cambridge Associates LLC.
Notes: Value created represents total gains (total value minus total investment costs). All VC Value Created is inclusive of the top 100
investments.
Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Total Gain Rank
Source: Cambridge Associates LLC.
Notes: In each year, investments were ranked 1 to 100 by total gains and then grouped by top 10, 11 to 20, and 21 to 100. Labels on bars are
the pooled gross MOIC for the investments in each ranking range. In 1995, for example, investments in the top 10 accounted for over 60% of
the total gains generated by the top 100 investments and generated a pooled gross MOIC of 137.1x.
Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Gross MOIC Range
Source: Cambridge Associates LLC.
Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Initial Deal Stage
Source: Cambridge Associates LLC.
Note: Labels on bars are the pooled gross MOICs for the investments in each deal stage, which was determined by deal stage at time of investment.
Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Deal Geography
Source: Cambridge Associates LLC.
Note: Geography detemined based on location of investment.
Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Fund Status
Source: Cambridge Associates LLC.
Notes: Fund status determined by stage of fund at time of investment. New & emerging funds deﬁned as funds I–IV and established funds as V
or greater.
Ex US Investments as a % of Total Gains Generated by Emerging and Established Firms in Top 100
Source: Cambridge Associates LLC.
Notes: Fund status determined by stage of fund at time of investment. New & emerging funds deﬁned as funds I–IV and established funds as V
or greater.
Total Gains in the Top 100 Investments: Percentage of Total Gains Generated by Fund Size
Source: Cambridge Associates LLC.
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